How much do you have to earn by buying a better interest rate?
The answer might be more than you think.
On their own, bank interest rates generally seem quite low. It’s only when you apply them to your deposit size and calculate how those deposits can grow over time that you see how it all adds up in real dollars.
One of the keys to this growth is the compound interest rate calculator.
The impact of interest rates increases over time due to compounding. This means that over time you earn interest not only on the amount you deposited, but on the interest you previously earned.
The Compound Interest Calculator below shows how these amounts can grow your money over time.
Instructions for the compound interest calculator
Here are some step by step instructions on how to use this calculator:
There are four input fields in the Compound Interest Calculator. Just enter your information and press Tab to move to the next field. Here’s what to grab:
1. Your initial deposit:
Enter the amount you have available to save up front. Don’t bother with dollar signs or commas – the calculator will take care of it automatically.
2. Years to save
Enter the number of years you will keep this money on deposit in your account.
3. Estimated rate of return.
Enter the interest rate on your current bank account or whatever you are considering. Once you have entered a deposit amount, the calculator will display some of the featured banking offers. You can click on any of them to have the calculator automatically display how their interest rate will grow your money, or you can enter a rate yourself.
4. How often is interest compounded?
Select a dialing frequency from the menu: Daily, monthly, semi-annually or annually. Note that if you enter an APY rather than a simple interest rate, choose “Annually” because the APY already takes into account the dialing frequency.
When you click the Calculate button, your results are displayed immediately below. The amount is the amount of money you will have available at the end of the period you have selected. However, this does not take into account the effect of the charges on the account. Be sure to check the fee schedule carefully before signing into an account.
What is compound interest?
When an account earns interest and that interest is left in the account, the interest previously earned itself begins to earn interest. Here is a simple example:
- $ 100 earns 10% interest. This comes down to $ 10 in interest, so the account is now worth $ 110.
- Over the next period, that $ 110 earns 10% interest. This comes down to $ 11 in interest, so the account is now worth $ 121.
Note that even though the interest rate remained the same, the account earned more during the second period. This is because he earned interest on both the initial investment and the interest that had been earned during the initial period.
This process of earning interest on interest is known as compounding. It makes a big difference in how investments grow over time, and the longer you stay invested, the more funding helps you.
Due to funding, four factors determine how much interest your savings will earn:
- Amount invested
- Interest rate
- Compound frequency
- Duration invested
The compounding frequency refers to how often the bank credits interest to your account so that you can start earning additional interest on the interest already earned.
If an account is compounded daily, that means if you earn interest one day, that interest starts earning interest the next day, this is called daily compound interest.
If an account is compounded monthly or annually, it will take a little longer for the interest you already earned to start earning additional interest.
Interest rate vs APY
Due to compounding, the amount of interest you earn may be more than the interest rate multiplied by the amount invested.
If you simply apply the interest rate to the amount invested, it assumes that no capitalization takes place during the year. However, if the account compounds interest more frequently than once a year, it should earn additional interest due to the compounding effect.
When the amount of interest generated each year after the membership is recognized is measured as a percentage of the amount invested, it is called the annual percentage return, or APY.
How often an account escalates interest makes a subtle difference, but over time every little detail counts. This is why you should always compare APYs rather than just interest rates, as APY includes the impact of how often the account compounds interest.
What to watch out for: other factors besides interest and APY
APY is very important when buying deposit accounts, but it is not the only factor you should consider.
Here are three other factors to consider when choosing a deposit account:
- Federal deposit insurance.
Make sure the account you are considering is covered by federally backed insurance – either through an FDIC member bank or an NCUA member credit union. Not all cash management products are eligible for this type of federal insurance.
Some interest rates are not as good as they seem because you have to pay regular fees to get that interest rate. Be sure to check how much the interest you earn will be offset by the fees. In some cases, the fees can wipe out all the interest you earn.
- Penalties for early withdrawal.
CDs generally offer higher interest rates than savings accounts and money market accounts. Just make sure you’re willing to leave your money on the CD for the duration of that CD, or you’ll likely have to pay an early withdrawal penalty.
- Rate levels.
Some banks charge different interest rates for different sizes of deposits. One promotional trick is to offer a great interest rate, but only on a very limited amount of money. With this type of rate level, unless you make a small deposit, the rate you earn may not be as good as the rate advertised by the bank.
Choose the right type of account to earn interest
Before you start comparing APYs and fees on deposit accounts, you need to decide what type of account you want.
Money market accounts and savings accounts have very similar characteristics. Each earns interest and allows you to withdraw your money at any time (although a few days’ notice may be required in some cases).
So, you can use money market accounts and savings accounts in the same way. You can compare the two types of accounts and choose the one that has the best APY with no fees and a minimum balance requirement that you can easily meet.
CDs are different. They usually require you to hold your money for a specific length of time, in exchange for which they typically pay higher rates than money market or savings accounts.
So, a key factor in your decision is when you expect to need the money. If you are sure that you don’t need to withdraw the money for several months or even a few years, you can commit to a CD in order to earn a higher interest rate.
How to find the best savings and money market rates
Since savings accounts and money market accounts can be used in the same way, you can consider both types of accounts and choose based on factors such as:
- Will your account be insured by the federal government?
This means ensuring that the money is deposited into a qualifying account at an FDIC insured bank or NCUA insured credit union. Remember that this insurance is limited to $ 250,000 of your total deposits at a single financial institution.
- Can you meet the minimum account requirements?
Some accounts have different requirements as to how much you need to open an account and how much balance you need to keep in the account. Focus your attention on accounts with requirements that your deposit will be able to meet.
- How competitive is APY?
Compare money market and savings account rates on the MoneyRates.com rates page, or start by looking at a few selected accounts displayed at the end of this section.
- Will the APY apply to your full account?
See if the account has different rate levels that will affect the amount your money will earn.
- Are there monthly maintenance fees?
These fees decrease or may even wipe out the interest you earn, so avoid them when choosing a savings or money market account.
How to find the best CD prices
If you decide that you are ready to commit to a CD in order to gain more interest, here are a few things that should be considered in your choice:
- Will your account be insured by the federal government?
Like savings accounts and money market accounts, CDs are eligible for deposit insurance. This only applies if your money is deposited into a qualifying account at an FDIC insured bank or NCUA insured credit union. Again, this insurance is limited to $ 250,000 of your total deposits at a single financial institution.
- Can you meet the deposit requirement?
Some CD offers only apply to certain account sizes, so focus your research on offers that apply to the amount you want to deposit.
- How competitive is APY?
The interest rate on a CD is usually locked in for the life of the CD. This makes the buying rate especially important when choosing a CD. You can find CD deals on MoneyRates.com’s CD rates page, or you can start by looking at a few selected accounts in the table at the end of this article.
- What are the early withdrawal fees?
You should not choose a CD if you are likely to need to withdraw money before the CD’s life expires. Just in case, if the APYs of two CDs are quite similar, you can compare the early withdrawal fees. Seeing who has the lowest early withdrawal fees could be the tiebreaker.